Last week, in United States v. Stein, Judge Kaplan found a portion of the DOJ guidelines, followed to assess cooperation contained in the Thompson Memorandum, unconstitutional. No. S1 05 Crim. 0888 (LAK) (S.D.N.Y. June 26, 2006), Specifically, the court found that “so much of the Thompson Memorandum and the activities of the USAO as threatened to take into account, in deciding whether to indict KPMG, whether KPMG would advance attorneys’ fees to present or former employees in the event they were indicted for activities undertaken in the course of their employment interfered with the rights of such employees to a fair trial and to the effective assistance of counsel and therefore violated the Fifth and Sixth Amendments to the Constitution.” Id. at *82-83.

While the court declined the defendants’ request to dismiss the case, it directed the government to adhere to its representation to not consider KPMG’s payment of defense fees in assessing compliance with the deferred prosecution agreement (DPA). The court also directed the clerk of the court to open a civil docket number for the filing of appropriate claims against KPMG. This ruling follows the recent action of the United States Sentencing Commission, which amended its guidelines to delete comments that had previously permitted courts to consider whether a corporate defendant had waived the attorney-client privilege in assessing cooperation and acceptance of responsibility for assessing whether a downward departure should be made.

The ruling by Judge Kaplan and the action of the Sentencing Commission are welcome and long overdue steps in reforming the standards on cooperation. The actions of the SEC and DOJ have put extreme pressure on companies to waive the attorney-client privilege to try and build up “cooperation points” to avoid harsh sanctions. This has caused serious erosion to the attorney-client privilege and, in the long run, can only serve to undermine the quality of the legal advice given to companies, thereby undermining the goals of law enforcement. Similarly, government review of whether defense fees are paid has placed companies under extreme pressure to breach long-standing arrangements as Judge Kaplan found in his ruling. Again, such action by the government can only erode effective enforcement of the law — the government cannot enforce the law by trampling on people’s rights. When that type of action is taken, there can be no doubt that we all lose.

Hopefully, in light of Judge Kaplan’s ruling and the Sentencing Commission’s recent amendment of its guidelines, both the SEC and DOJ will rethink their approach to cooperation and refashion it in a manner that will foster good law enforcement and respect for the rights of those under investigation.

Current focus areas for the SEC Enforcement Division include the issuance of stock options and the misuse of medical research data. Investigations concerning the former have increased greatly. For example, a recent report in the New York Times on June 7, 2006, states that at least 34 companies have disclosed criminal, regulatory or internal investigations concerning options. S.E.C. May Act on Options, N.Y. TIMES, June 7, 2006, at C2. These investigations appear to focus on whether the grants were backdated in an effort to give executives the benefit of a more favorable stock price. Chairman Cox recently termed such option grants “of serious concern.” Backdating stock options raises a number of issues depending on the facts and circumstances, which include, for example, the accuracy of the disclosure concerning the options, how the company accounts for the options grants (see, e.g., APB 25 “Accounting for Stock Issued to Employees”; FAS 123 “Accounting for Stock-Based Compensation”), whether the grants were reported properly under Exchange Action Section 16, the accuracy of SOX certifications, and tax law issues. The Justice Department is also investigating options grants and, as expected, the class action bar has weighed in with a number of cases.

Other inquiries appear to focus on the timing for the issuance of options. In these investigations, the Enforcement staff appears to focus on whether the options were issued to executives and directors prior to a significant corporate event, such as a merger, and prior to a public announcement of the event. The issues in these inquiries focus on questions concerning insider trading in violation of the antifraud provisions of the federal securities laws.

The use of medical information is another area of Enforcement interest. Following press reports last summer that Wall Street investors routinely paid for medical information about ongoing drug studies, Senator Chuck Grassley called for investigations by the SEC and the Justice Department. See, e.g., Saul, Stephanie and Jenny Anderson , Doctors’ Links With Investors Raise Concerns, N.Y. TIMES, Aug. 15, 2005, § A; Editorial, Tainted Drug Research, Boston Globe, Aug. 15, 2005; Justin Gillis, SEC to Probe Drug Research Test Allegations, WASH. POST, Aug. 10, 2005; Jenny Anderson, Today’s Insider Trading Suspect May Wear a Lab Coat, N.Y. TIMES, Aug. 9, 2005, § C.


Subsequently, the SEC has initiated enforcement actions. Two action are pending. First, SEC v. Alexander J. Yaroshinsky, Civil Action No. 06CV2401 (S.D.N.Y., filed March 28, 2006), which involves a complaint against the vice president of Connetics Corp., charging him with trading on inside information regarding the FDA’s preliminary reaction to a study relating to cancer tests of Connetics’ acne drug. Second, SEC v. Selden, Civil Action No. 05cv11805 (NMG) (D. Mass., filed Sept. 1, 2005) involves a complaint against the CEO and director of a biotech company that had issued materially false and misleading press releases concerning clinical trials and its FDA application for its flagship drug. According to the SEC’s complaint, Sheldon traded in the company’s shares prior to the disclosure of some negative information about the flag ship drug and avoided significant losses.  

The SEC settled a third action. In SEC v. Sanjiv S. Agarwala, Civil Action No. 06 CV 0352J (POR) (S.D. Cal.), the Commission filed a settled enforcement action against a physician who participated in clinical trials for Maxim Pharmaceuticals and, according to the complaint, traded on material non-public information obtained from the FDA about Maxim’s drugs. The defendant consented to the entry of an injunction baring him from future violations of the antifraud provisions of the securities laws, agreed to disgorge his illegal trading profits and loss avoided, paid an equal amount as a penalty, and paid prejudgment interest.

SEC Chairman Cox has indicated that the Commission is coordinating closely with the FDA in its pharmaceutical related investigations.